FDIC Law, Regulations, Related Acts

4000 - Advisory Opinions

Taking Collateral for Loan Transfers Risk from
Affiliates to Bank

FDIC-87-56

December 23, 1987

Gerald J. Gervino, Senior Attorney

We are writing you with respect to issues raised in your October 12,
1987 letter to Mr. Donald L. Pfeiffer, Assistant Regional Director in
our San Francisco Office. In your letter, you dispute the mention of a
loan to *** as a violation of § 23A of the Federal Reserve Act, 12
USC § 371c (1982)("§ 23A''), in a recent report of examination
of the Bank.

It is undisputed that *** gave the Bank a deed in lieu of
foreclosure on the real estate securing participations originated at
***, and participated to the ***, all affiliates. As the originating
bank, *** repaid the participants and booked the collateral as other
real estate. Our examiner feels that this transaction constitutes the
repurchase of a low quality asset in violation of § 23A.

You have enclosed copies of the participation certificates with the
three affiliated participants. You highlighted language on these
certificates which states that "the selling bank (*** ) shall apply
all remaining collections on the loan, whether from customer, any
guarantor, proceeds of collateral or otherwise to the pro rata
repayment of all indebtedness represented by the participated interest
of participants other than selling bank . . ." You feel that
since the value of the property received by the bank as a result of the
deed in lieu of foreclosure exceeded the value of the participations of
the three affiliated participants, the actions taken by the bank in
repaying the participants from the appraised value of the repossessed
real estate was not only consistent with the participation certificate,
but required by it. Thus, you believe that the transaction does not
constitute a violation of § 23A as cited by our examiner.

We feel that our examiner is correct since the Bank has taken
collateral and used it to favor affiliates at the expense of itself.
Thus, the Bank has eliminated any risks the affiliates may have had and
transferred such risks to itself. In our view, this constitutes a
purchase of a low quality asset within the meaning of § 23A(a)(3).
We note that the participations provide an express exception for cases
of default and further provide that collections after default shall be
applied to the pro rata repayment of indebtedness represented by
the
participating interests of the
participants. Thus, the participation certificate, does not provide any
priority for nonselling bank participants in the case of a default.
While "default" is not defined in the participation agreement, it
seems obvious that a release of collateral in lieu of foreclosure
should constitute default in any agreement where "default" is not
defined. In any case, the terms of the participation certificate would
not preclude a violation of § 23A if they allowed a repurchase of a
low quality asset from an affiliate. The statute would simply preclude
the agreed provision from being followed.

Under the facts presented to us, it appears that the examiner's
citation of the transaction mentioned above as a violation of § 23A
of the Federal Reserve Act appears
correct.